Here's something to ruminate on: how a traditional bank makes money. Sure they earn some fee income, but banks "sell" money in the form of loans, certificates of deposit (CDs) and other financial products. They make money on the interest they charge on loans because that interest is higher than the interest they pay on depositors' accounts. Now, let's think about Freddie Mac's regular releases noting average mortgage rates (you LO's know what I am talking about - the rate that your borrower sees in the newspaper and wants you to match or beat). Freddie reported that the average 15-yr mortgage was down to 2.69%. For an average bank, to make any decent money it needs a spread of 3% between what it pays for funding (deposits) and what the bank earns on its assets. So at this point, few banks want this paper, and many sell them or execute a swap for adjustable rate assets. (In a related note, money market funds hold $2.5 trillion in cash and are paying a 0.03% average yield now.)

What is a derivative? Webster’s defines it as, “a contract or security that derives its value from that of an underlying asset (as another security) or from the value of a rate (as of interest or currency exchange) or index of asset value (as a stock index). The industry needs to know that a security backed by mortgages fits this description. The industry also needs to know that the Volcker Rule would prohibit banks from using derivatives. (Remember that the Volker Rule is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and aims to put an end to proprietary trading by banks on their own accounts. Proprietary trading is when a company trades stocks, commodities, derivatives etc. using its own cash reserves to make a profit for itself. The goal of the rule is to simply stop the banks trading for profit because the taxpayer will be responsible for terrible mistakes.) In what could be another unintended consequence, if a bank can’t use mortgage-backed securities to hedge locked pipelines, how does that help a borrower that likes today’s rates but is dealing with a bank that will take 75 days to fund the loan? The MBA is continuing its work on the Volcker Rule (and possible increased industry-wide margin requirements in trading with dealers), and is forming a working group for each issue. Any member who would like to be a part of one or both of these working groups should e-mail Dan McPheeters today at DMcPheeters@mortgagebankers.org.

On the commercial real estate side of things, Flagstar Bancorp announced that it has entered into a definitive “Transaction Purchase and Sale Agreement” under which a wholly-owned subsidiary of CIT Bank, the U.S. commercial bank subsidiary of CIT Group Inc., will acquire a substantial portion of Flagstar's Northeast-based commercial loan portfolio. "This transaction is another step in renewing Flagstar's focus on our community banking operation in Michigan and our national mortgage business," said Michael Tierney, Flagstar president and CEO. Under the terms of the Agreement, CIT will acquire $1.26 billion in commercial loan commitments, $785 million of which is currently outstanding. The loans sold consist primarily of commercial real estate loans, asset-based loans and equipment leases. Here is more info: http://www.crainsdetroit.com/article/20130103/NEWS/130109954/flagstar-to-sell-northeast-based-commercial-loans-to-cit-bank.

“Rob, I run compliance for a mid-size bank in Georgia, and our senior management told us that we don’t have to worry about what the CFPB is doing. Do you agree?” No, I don’t. It is commonly quoted that the CFPB doesn’t have any jurisdiction over banks with less than $10 billion in assets. (Put another way, Dodd-Frank expressly gives the CFPB jurisdiction over banks with more than $10 billion in assets.) It is incorrect to think that what the CFPB does won’t have an impact, directly or indirectly, on the policies, procedures, complaint handling, methods of pricing loans, and so on for every lender. The CFPB’s rules will apply to banks they don't directly examine, the CFPB can obtain reports from their examiners and the CFPB can also ride along with the other examiners. It was recently announced that the Bureau is sharing information with state regulators.

And obviously an industry has been created to prepare companies for CFPB exams. There are many examples, but I was talking to someone who'd just had a Garrett, McAuley & Co. CFPB Readiness Review, and she found it very worthwhile. "They gave us a long to-do list at the end, but at least I feel we now have a good chance of surviving the real thing when the CFPB shows up." If you want more information on this one, contact industry vet Joe Garrett at Garrett, McAuley at JGarrett@Garrettmcauley.com.)

What are you doing mid-day on January 8th? The Consumer Financial Protection Bureau and the Federal Housing Finance Agency have partnered to develop a National Mortgage Database that is envisioned as the first comprehensive repository of detailed mortgage loan information. “While the goal—better informed policy decisions and understanding emerging mortgage and housing market trends—is laudable, there are concerns about how the proposed database is being sourced, analyzed, and shared. Please join us (Ballard Spahr) for an interactive webinar that will give you the information you need to know about this initiative. Topics will include: The scope and use of the proposed database, critical considerations around data collection and analytics, the challenges the industry will face with compiling the data, and privacy and data security concerns.” Here is a site for more information: http://www.ballardspahr.com/en/EventsNews.aspx.

Whether it is a CFPB exam or an audit from a federal or state banking regulator, it is important for bank directors and management teams to know their duties and responsibilities. Regulators expect directors know and understand they have a fiduciary duty to shareholders and depositors, and make sure policies are defined properly and that management is ready, willing and able to do a proper job. In addition, regulators point out that responsibility lies with the directors and it cannot be delegated, but it can be assigned for others (management) to complete. One place to do this is when preparing for an exam. Here, directors and management should know that regulators often begin their process by analyzing the most recent financial information (Call Reports, etc.), reviewing prior examinations, Board minutes, audits, plans, and policies. That gives a good overview of the institution and gets the ball rolling related to areas that might need a closer review (such as concentrations, insider activity, capital planning, asset disposition, etc.).

Some banks and lenders do a dry run “mock exam” which starts by looking with a fresh set of eyes at recent meeting minutes and in the way management reviews prior exams, audits, etc. Look at anything that might need more explanation. Institutions tend to do this about two months prior to an exam to have enough time to prepare since this gives personnel time to create checklists, add explanations where needed, and document significant actions for changes. I am not a big fan of PowerPoint presentations, but they help in summarizing the company and highlighting its history, policies and procedures, primary activities, and strengths.

Make sure planning documentation is thorough. The Pacific Coast Banker’s Bank suggests that this is one area where regulators are spending more time. “They want to know how you are using your capital, where you are taking risks and whether those risks are identified, measured, monitored and controlled. Make sure your plan continuously evolves based on present and future projections, your goals and objectives, and available resources. Then, track, analyze and report how things are going at the Board level and revise if needed.”

One of the things auditors and examiners look at is counterparty risk, and the trend toward looking at closing agent counterparty risk continues. Andrew Liput with Secure Settlements writes, “Within the past week we were contacted by a large warehouse bank. A title agent that was on their approved list had been in the news due to a major defalcation that cost a major title underwriter and the banks associated with several transactions a large loss. The warehouse bank wanted to know if there were any warning signs with respect to the individual at the agency behind the fraud. Using only public information, we were able to determine that the individual was a defendant in litigation, had filed for bankruptcy and had other serious personal and business issues in the 24 month period leading up to the incidents. In sum, this agent would have been labeled high risk under our program and the fraud would likely have never occurred. By the way the individual in question was licensed and was an authorized agent of a large title insurer. This is another instance proving out the value of a new approach to agent risk management. The agent’s E&O coverage will not cover the fraud, and the CIL may cover some or all of the loss, but at what cost to the innocent parties involved?  Risk management works best when it prevents fraud from happening in the first place.”

Yesterday the 10-yr T-note’s yield closed at 1.90%. What the heck happened? What happened was that the Federal Reserve released the minutes from its last Open Market Committee meeting, and although 12 voting members thought the bond purchases would be warranted through the end of this year others felt the purchases should be slowed or stopped altogether before the end of 2013. This group was concerned that too much bond buying by the Fed might destabilize the economy. Federal Reserve policy makers said they will probably end their $85 billion monthly bond purchases sometime in 2013, with members divided between a mid- or end-of-year finish. 

Remember that overnight Fed Fund rates, one of the few rates which the Fed actually sets, has been near 0% for four years. The meeting’s minutes show a divide among FOMC participants on how long the purchases should last. Participants who provided estimates were “approximately evenly divided” between those who said it would be appropriate to end the purchases around mid-2013 and those who said they should continue beyond that date.

Suddenly the market answered what folks have been asking for a while: “Where would rates go if the Fed wasn’t there to support our yields and prices?” Asset purchases are not forever: it's not that markets think that The Fed's purchases of MBS (the "mortgage backed securities" that most directly influence mortgage rates) or Treasuries will be stopping any time soon, but however long a particular market participant thought that QE would continue, that time frame was either shortened or called into question after today's data. Half the e-mails I received yesterday afternoon were investor price changes. But widespread mortgage banker selling didn’t ensue – and given anecdotal stories, lock desks are pretty slow – so there isn’t much to sell. (Remember the MBA’s application numbers for the last couple weeks.)

Prices on 30-year FNMA 3.0s and 3.5s (containing 3.25%-4.125% mortgages) fell/worsened almost .5 and .375, respectively, while 10-year notes dropped .5 in price and closed at 1.90%. Thomson Reuters reminds us that even though the 10-year note yield has worsened over 30 basis points since early December, not all of this is appearing in worsening MBS or rate sheet prices – some of it is being absorbed in the cushion of profit margins.

But today we had the employment numbers. Prior to them coming out, the 10-yr had crept up to 1.95%. The consensus for nonfarm payrolls was +150-190k jobs created with the unemployment rate steady at 7.7%. The rate came in at 7.8% with nonfarm payrolls coming in at +155k. Hourly earnings and hours worked shot up, which attracted some attention.

We still have the non-market moving Factory Orders and ISM Non-Manufacturing ahead of us, but in the early going the 10-yr is at 1.93% and current coupon mortgage-backed security prices are a shade worse.

Here we are in January, which is typically a month filled with kick-off meetings, dinners, and morale boosting team events for mortgage companies and Realtors. Here is a short clip of a great team building event that management can try during the open bar portion of your meeting: http://www.youtube.com/watch_popup?vK1HWyUIZ5kk&featureplayer_embedded.

If you're interested, visit my twice-a-month blog at the STRATMOR Group web site located at www.stratmorgroup.com. The current blog discusses the role of the IRS and REMIC’s in the current credit crisis. If you have both the time and inclination, make a comment on what I have written, or on other comments so that folks can learn what's going on out there from the other readers.

Rob

(Check out http://www.mortgagenewsdaily.com/channels/pipelinepress/default.aspx or www.TheBasisPoint.com/category/daily-basis. For archived commentaries, go to www.robchrisman.com. Copyright 2013 Chrisman LLC.  All rights reserved. Occasional paid notices do appear. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Rob Chrisman.)